How Important Is California to Dunkin' Donuts?

Dunkin Brands is taking Dunkin' Donuts to the California sun, but that doesn't mean that success is coming overnight.

Jun 25, 2014 at 3:11PM

The dream of the Oregon Trail never dies. Companies fire up in the East, build a head of steam, and then push out across the Midwest to find their fortune on the West Coast. Dunkin' Brands (NASDAQ:DNKN) is one of the most recent brands to hitch up the wagon and make the trek. Its Dunkin' Donuts brand has finally reached the sunny shores, and it looks like this could be a massive new revenue stream.

One major advantage Dunkin' Brands has is that it already runs businesses in California, so the territory isn't brand new. Its Baskin-Robbins brand was actually founded in California, and it now operates 455 locations in the state. That connection made it easier for Dunkin' Donuts to get off the ground there, and the company will beat its forecast by opening stores in 2014 -- it had anticipated opening locations in 2015. 

California's love of coffee
California is no stranger to coffee. Starbucks (NASDAQ:SBUX) operates around 2,000 stores in California, making it the company's most popular state. It's a place that has plenty of demand for Dunkin' Donuts to meet. The sales trend at Dunkin' Donuts suggests it should be met with open arms.

Comparable-store sales were up 3.5% last year in Dunkin' Donuts' U.S. locations. The brand has made a huge push over the last few years, growing quickly from its stronghold in New England. The announced push into California will start with construction this month on five locations, four around Los Angeles and one in Modesto. 

Those locations will be followed by another 200 in the next few years, cementing a foothold in the California market. In total, Dunkin's early California expansion will represent a drop in the company's total distribution bucket. There are currently over 7,500 locations in the U.S., and Dunkin' Brands has said it plans to get that figure to 15,000 largely through expansion in the West. That means the end store count in California should hit closer to 1,000, the company says, but that's many years away.

The value of a new store
Earnings in new Dunkin' Donuts stores are slightly lower in the West right now. Whereas the brand can drive close to a 15% EBITDA margin in the Northeast and other established regions, stores out west bring in closer to 12%. That doesn't mean it's a bad setup for Dunkin', it just means that the growth is going to take a little extra time.

Starbucks does a better job of opening new locations. According to Starbucks management, it averages $1.2 million in average first-year sales and achieves a 50% return on investment. There's something in those figures that Dunkin' could learn from, as its first-year stores have lower sales and lower returns at $936,000 and 25%, respectively. 

Overall, the expansion into California is good long-term news for Dunkin' Donuts, but in the short term, it's likely to have very little impact. What it does highlight is just how much room Dunkin' has to grow. Of its thousands of locations, only about 250 are west of the Mississippi right now. That represents a huge potential and a great future for this business.

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Andrew Marder has no position in any stocks mentioned. The Motley Fool recommends and owns shares of Starbucks. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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